With all of the news regarding the issues between Hostess Frito Lay and Loblaw we had to tackle the definition for cost of goods. This is certainly one of the most critical components of the relationship between suppliers and retailers. The bigger the supplier, the more focus it will receive within the retailer. Google can provide definitions, but it does not always help you understand the importance of the term or perhaps even a specific meaning in our industry. We are going to share some food and beverage industry terms and explain how they can benefit or impact your business.
Cost of goods, to a retailer, is the price they pay for products delivered to their warehouse or store. It sounds simple but it gets very complicated quickly. Most retailers will consider the everyday cost they pay, but they will also factor in the over and above dollars invested by the supplier. If the everyday cost for a product is $20 per case and in the latest fiscal year the supplier also invested the equivalent of $3.50 per case, the retailer will assume the supplier’s true cost is $16.50. The retailer will base negotiations for the next year on this $16.50 figure. The $3.50 per case can include a lot of different things like off invoice deals, over and above dollars for ads or themes, or any other money the supplier spent with the retailer. The negotiation for the upcoming year can include the everyday cost but the retailer will always include the extra $3.50.
Hostess and Loblaw
Before we dive into the components of cost of goods and what suppliers should be doing let’s talk about the situation between Hostess and Loblaw. To be clear, I do not know the details and likely none of us ever will. However, we can speculate and watch to see what happens.
When a large company like Hostess (owned by PepsiCo) decides to stop shipping to a retailer, that is over 30% of the Canadian market, we know the dispute has reached a boiling point. It is also interesting to see Loblaw also draw the line in the sand when Hostess are the exclusive branded supplier of chips to their Shoppers Drug Mart (SDM)stores. I am sure the SDM operators are very vocal to Loblaw to get the situation resolved. Chips are an important part of their sales mix.
Food inflation is in the news. I am sure Hostess are dealing with increased cost of potatoes, increased costs for packaging, inefficiencies in labour due to the pandemic and more expensive distribution as fuel and trucking costs rise. There is no doubt, probably even from Loblaw, that the price needs to increase. How much is fair will be the issue.
There are a number of scenarios that could be at play. The most obvious is that Hostess proposed an increase and Loblaw felt it was too high. For Hostess to stop shipping, one would think there is more to the story. There is no doubt retailers use any information they can find to manage cost increases.
A big source of information is from their private label costing. For example, if Loblaw believe their President’s Choice (PC) kettle chips are very comparable to Hostess Miss Vickies, then Loblaw would compare the cost of PC to Miss Vickies. If the PC price increase was 5% and Hostess wanted 7% Loblaw would push back.
Another factor could be Hostess changed their cost in 2021 and now want to increase it again. Loblaw could believe the impact of both increases is not fair, given their expectation for rising costs.
We know the retail landscape is very competitive and there could be an issue with Loblaw’s perception of other retailers in the market paying less. Canadian retailers will always focus on Walmart and Costco when challenging cost of goods. Both companies are much larger than Loblaw and US based. Suppliers could make the case their overall business with Walmart or Costco is much larger than Loblaw and a lower cost is justified because they are more efficient to deal with. Could be true but Loblaw will not be buying that argument.
The dispute could be related to promotion activity. As we said earlier, retailers will consider the everyday cost and the amount suppliers spend on ads and other promotions. Perhaps Hostess wants to reduce promotion activity and Loblaw believes in the end they will be paying more.
Hostess products are direct store delivered (DSD) which complicates cost of goods. It is easier to compare cost of goods for products delivered to the retailer’s warehouse. When they are DSD, the retailer understands there will be distribution costs and money saved because they do not have to do it. The challenge is retailers usually believe they can do it more efficiently. With stores the size of Loblaw the retailer will make the argument ‘you have to charge us less because every stop is bigger than our competitors and convenience stores. Bigger volume is more efficient so charge us less or charge them more’. Perhaps part of the dispute is related to an increase Hostess believes is justified for increased delivery costs.
It can be a challenge to rationalize the true food cost when you look at retail prices. This week the regular retail for Ruffles Chips was $4.99 and this week you could buy 2/$9.00. I am not an expert in manufacturing potato chips but a 200g bag of chips probably requires about 1.5lbs of potatoes which cost Hostess +/- .30. Obviously, there are other costs and the retailer’s margin is included in the $4.99, but it could be that Loblaw has decided they cannot see the retail going above $4.99. The cost increase proposed by Hostess might force them over this threshold to maintain their margin and Loblaw cannot justify the components of the increase with their understanding of commodity prices.
We will probably never know what caused Hostess and Loblaw to get to this point but it is likely one or more of the factors we have outlined. No doubt it is two big companies staring each other down. When I visited our local store the chip aisle was full of Hostess products which was surprising. When I checked the atlanticsuperstore.ca website there was no sign of a Hostess chip.
Bedford Superstore February 22, 2022
A retailer’s perspective
We know there are a lot of conversations in our industry right now about inflation and how cost of goods are increasing. Retailers get very uneasy when there are a lot of proposed cost increases. They understand costs are rising, they see it in their own business.
They get nervous and upset when they believe suppliers are trying to increase cost of goods more than what is justified. This causes great irritation for retailers and trust with suppliers can be eroded.
When retail prices rise consumer behaviour changes. Some people trade down within the category. In other words, they buy less expensive items they see as replacements. Retailers can benefit if consumers shift from national brand to their private label or control label, which can be lower priced. The issue for retailers is when people trade down (other than private label) it can be to lower margin items.
When prices increase, people shift to more flyer items with lower margins. This can have a negative impact on the overall store margin. Consumers ‘cherry pick’ more.
Retailers can believe certain items have a threshold retail and if the price goes above that the sales will decline. It can be difficult to prove but if you use my chip example above I might turn away from a bag of chips over $5.00. If the supplier’s cost of goods goes up and to maintain the category margin they have to go over the threshold they will worry about volume, usually their number one goal. Suppliers can say ‘take less margin’ but not always an option.
Retailers worry a lot about a level playing field. They can be almost too fixated on what their competitors are paying for a product. If they perceive a supplier has given a better cost of goods to another retailer, they will always be trying to force that supplier down in cost of goods or reward their competitors with more volume.
What suppliers should do about cost of goods
Obviously cost of goods is a major area of focus between suppliers and retailers. In this period of food inflation there will be more focus.
The first thing is to stay on top of your costs and if your costs are rising work to get the price increase necessary. Do not put it off and expect to recoup the dollars in the future. Smaller increases justified by commodity cost increases or realistic changes to your packaging costs are easier to justify than a bigger one, next year.
Talk about your operation regularly with your customers. Even when you are not trying to get a cost increase through talk to them about what is happening. You want the conversation about a cost increase to really be a forgone conclusion as opposed to a surprise. When you share increases in packaging or other input costs, they will understand it is coming.
Negotiate your own costs and tell retailers you were able to reduce a 10% increase in something to a 7% increase. They want to hear you are fighting to keep prices down. They understand it might have to go up but they see a lower increase as a victory.
Do your best to maintain a level playing field. This is easier said than done but keep in mind this is how they look at it. If you are DSD with one retailer and warehouse with another this will impact cost of goods.
During non-contentious meetings share when they do things that drive your costs up. During an argument they will not listen but at other times plant the seed as to what they do that costs your business more money.
Track your everyday cost and your promo spend by retailer. They will so you need these facts. Understand they will compare the everyday cost and the dead net cost (everyday cost less everything else you spent with them) so you might as well too.
Understand the windows when they will entertain cost increases. This might seem restrictive but its how they choose to run their business. You will have a much better chance if you work within these. Follow up because they have a habit of taking far too long to approve increases.
Talk through your strategy right to the end. Hopefully you do not have to go as far as Hostess, but others have and unfortunately others will. Be prepared to go the distance as you have defined it and if you blink, they will remember.
The last and a very important point is do not tell the retailer how to run their business. Do not tell them the right retail or what they can do to be more efficient. Focus on your own business and deliver the best, fair cost you can. You should always have a optimal retail in mind if they ask the question but not tell them before they ask. They will get their back up and your negotiations will be off to a rocky start before you get too far.
If you have any questions or require help with cost of goods or price increases, you can always send me an email peter@skufood.com or call me at (902) 489-2900.
Peter
As we start into the new year we are going to focus on some terms in the food and beverage world for upcoming weeks. I am going to select a different term each week and give you a good definition and also some insights into why it could be important for your business. If there are any terms you would like me to focus on just let me know.
If you see things happening let us know so we can share them with our community. We also want to hear if you find this helpful and benefits your food and beverage business!
Hostess and Loblaw in the news
It will be interesting to see how long this dispute lasts. They both have options and many other suppliers will be watching.
A customer shops at Harmons Grocery store in Salt Lake City, Utah, U.S., on Thursday, Oct. 21, 2021. More than a year and a half after the coronavirus pandemic upended daily life, the supply of basic goods at U.S. grocery stores and restaurants is once again falling victim to intermittent??shortages??and delays. Photographer: George Frey/Bloomberg via Getty Images
Dairy products rising in price
To add to the conversation about food inflation, we see reports about dairy pricing. There is a price for a safe, sustainable food industry. Every time the price changes for the cost of fluid milk, we will see the impact in retail prices.
When is Peter speaking?
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